Overwhelming

The statement from the Bank of Mexico last Thursday where they announced the decision of the Governing Board to increase the overnight funding rate by 75 base points to place it at 7.75%, indicates that as a result of various events, practically all of a international and all as negative real supply shocks, “the balance of risks regarding the expected trajectory for inflation in the forecast horizon presents a considerable upward risk”.

Thus, an upward revision is made of the forecast trajectory of inflation for the following quarters (as the economists they are, they dared to make a forecast until the second quarter of 2024). For the remainder of this year, with less probability of error than forecasting what will happen in the next century (in terms of economic forecasts, making a two-year forecast has the same probability of coming true as a 100-year forecast), the Bank estimates that In the second quarter, average inflation, measured with the INPC, will be 7.8% (core is estimated at 7.3%), while for the third and fourth quarters, average inflation is forecast to be 8.1 and 7.5%, respectively (core is estimated). for these two quarters it is 7.4 and 6.8%).

As I pointed out above, the events that, according to the Bank of Mexico, led them to revise inflation forecasts upwards are all negative real supply shocks. Thus, they mention the upward pressure on food and energy prices due to the “geopolitical conflict” (for some strange reason they do not make an explicit mention of Russia’s military aggression against Ukraine), external inflationary pressures derived from the pandemic (fueled by the strict confinement measures in China), the appreciation of the dollar against the peso and cost pressures (without making any specific mention to which costs they refer). As the only internal factor they mention the persistence of high underlying inflation.

Some comments about it. First, a negative supply shock pushes up the price of the good in question, but this does not necessarily have to cause a generalized rise in all prices in the economy, no matter how “important” this good is. Second, a real negative supply shock translates into an increase once and for all in the price of the affected good and this increase cannot cause an inflationary process in which prices generally increase in a sustained manner. Third, if an economy continually experiences pure negative real supply shocks such that domestic aggregate supply is continually contracting, the economy will eventually die out; That doesn’t happen no matter how inept they are in government and they make every effort to make it happen.

This brings me to the next point and that is monetary policy. If the economy receives several negative real supply shocks such that the price of some goods in particular increases, the only way for this to translate into an inflationary process is if the central bank carries out an accommodative monetary policy, expanding the base currency to validate the increasing nominal demand for money. This is aggravated if, in addition, the bank is slow to respond or does not respond to the required magnitude, so that the real ex-ante funding rate of the central bank becomes negative, which would imply a monetary policy that is not only accommodative but also openly expansive. , thereby fueling higher inflation expectations and higher inflation. And this is basically what happened from the second half of 2020 when, faced with the ever-increasing rise in core inflation, partially caused by negative supply shocks, in particular the pandemic, the Bank of Mexico not only followed a monetary policy accommodative but an expansive one.

The good thing is that going forward, the Board of Governors of the Bank of Mexico reaffirmed its commitment to reach its 3% inflation target by 2024 and, therefore, “intends to continue increasing the reference rate and will assess acting with the same forcefulness in case it is required”. Okay.

Twitter:@econoclasta